How to run CapEx Options?

Question

Hello All,

I am looking for advice on how to figure out CapEx when running the analysis on a deal. I have seen many different ways, but when trying to do it quickly I become quickly unsure. This seems to be the one item that quickly slows down and analysis as you can just get stuck in minitua. Does the house have a garage, how old is the roof, are we looking at AC, etc. If anything I tend to over estimate and then I know that can blow my numbers out of the water depending on the deal. So I am curious what methods some are using to do this?

One Method I have seen is using a Home Warranty to cover appliances and major systems. This costs 39 a month and then that covers some big ticket items. You still have to take into account roof, driveways, cabinets, landscaping, and structure though. Also when I run through what it does cover it seems to be mostly items that are cheaper like appliances. Also if you were to save this same amount and then not have to use it then you could possibly use the money not used on next deal. That said I am a buy and hold investor. How do you figure out CapEx when analyzing a deal in a way that is not labor intensive?

Aaron H. · Answer

Brandon's book on Rental Property Investing (in the BP store) has an awesome quick chart to help estimate Cap Ex (it's in Chapter 5). I think he said he stole it from Ben Leybovich or somebody else that knows what they're doing.

For each big cap ex item, you know either the average life span or a shorter number of years if e.g. you know the roof is going to have to be done in the next 2 years. If you don't know, use the average. You also know the replacement cost for each item. So if you know a roof costs e.g. $5000 and lasts 20 years, then you need to save $250/year, or ~20/month for the roof. Just make a small spreadsheet with the average lifespan and replacement cost for each big item, adjust a few year values when you're analyzing a property where you have additional info, and you have a pretty good estimate.

Or just call it 5% of gross rents and move on with life :)

Alvin Sylvain · Answer

I don't believe there is any hard and fast rule, but I have heard 5% of the rent is as good an adjustable rule of thumb any. It's "adjustable" in that you might lower it for new construction -- shouldn't need a new roof for at least 15-20 years -- and you might raise it if it looks like enough "deferred maintenance" may have caused irreparable damage to the heating system.

Other than that, I wouldn't bother itemizing all the things that might need major repairs or replacement eventually. Unless you're the accountant type by nature, that sort of thing will not only drive you batty, it's unlikely to have any actual predictive value. E.g., you're all set and ready to paint the outside in 5 years and your CapEx is saving up for that, when suddenly the rain gutters leak into the bedroom causing water damage to the floors. OK, so you fix the floors with the CapEx you've been saving, but you're still going to need to paint in 5 years!

EDIT: OK, bad example, you'd probably fix the floors with your insurance. But the point is, you're not really going to know how much a new roof will cost, even if you schedule to the minute when you'll need one. Since you can't really know how much CapEx you're really going to need in a few years, just pick a ball-park number and adjust it to your circumstances.

Aaron H. · Answer

It's less precise than exactly calculating out the lifespan and cost on every major system for your exact zip code and specific property, but it's also more precise than using a round 5% of gross rents (or whatever). There's always going to be a tradeoff between precision and convenience. Like Alvin said, there's a point of diminishing returns with trying to calculate all of it out, and actual cap ex expenditures happen based on real life, not your estimate, so it's mostly down to how much precision you need to feel comfortable. For me, I'm just trying to get a sense of whether I'm looking at $100/m because everything is brand new, or $500/m because everything is falling apart. The difference between $100 and $110 is irrelevant.

The reason the approach works reasonably well is because CapEx on a 100K house and a 500K house ARE actually pretty similar. A roof on a 1500sqft house is going to cost basically the same - the roof doesn't care whether the interior has granite countertops. The difference between the cost of 1 story and 2 stories is a small percentage of the total cost, especially averaged out over 30 years, so isn't really worth overanalyzing. A water heater is going to cost the same in both houses. Sure, your cap ex expenses will differ somewhat based on the price of the house, but think about it this way: in your example, the 500K house is 5x more expensive than the 100K house. But there's no way the Cap Ex is 5x more expensive. And if it's 1.2x more expensive, that's not really an important enough difference to worry about.

I wouldn't necessarily suggest using Brandon's exact numbers or using the same numbers in every state. But once you have a ballpark (e.g., a typical roof in WA state is $5000 or whatever you find out), you can use that number for each major area you invest in. But I'd also guess the price difference for a water heater is pretty similar in most markets. Do enough research to have a reasonable average ballpark on the major systems, make your best guess about where you're at in the replacement cycle, and call it good. This just gives you a way to say "this roof has 5 years left, not 30 years" and know that it will increase your cap ex estimate by approximately $X/m

Jonathan Woelfle · Answer

Thanks Aaron! I am using this to a degree, but just seems a little to imprecise. The roof on 1500 two story won't cost the same on a single story 1500. Also it seems these numbers stay static no matter the home you are buying which doesn't make sense to me. If you are buying a 100k house and a 500k house then why would we be looking at the same CapEx? I can get a lot more precise by pricing it all out, but that is going the opposite direction of making it easier. Using Brandon's numbers and offsetting with a Home Warranty I have my CapEx at 165 a month. That is 165 across the board despite if I am buying in North Carolina, Washington State, or Texas. Despite buying 400k home or 125k home. Cost of goods and building change per state. Hence me being unsure how to run these numbers.

How to run CapEx Options?

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